Why I Shy Away From Investing in Gold and Precious Metals
January 28, 2008
By Chandler Lutz
Recently, there have been few investments or commodities hotter than gold gold. With Gold indexes up nearly 30 percent over the last year while the S&P 500 is losing money it’s no wonder why gold investors and traders have recently been so giddy. To add to that, most of the gains in gold prices have come in the last three months. Kudos to the traders who made the right call; they have enjoyed excellent returns compared to traditional markets.
Despite their results (and the gloating of traders on CNBC) I’m still staying away from gold and the precious metals for a number of reasons.
Gold is a terrible Long term investment
In The Future for Investors
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| Asset | Value of $1 invested in 1802 at the end of 2003 |
| Stocks | $597,485 |
| Bonds | $1,072 |
| T-Bills | $301 |
| Gold | $1.39 |
| 1 Dollar | $0.07 |
Note that all these returns are inflation adjusted.
Clearly, Gold would have been an underperforming investment compared to stocks, bonds or even riskless Treasury Bills. One dollar invested gold in 1802 would only yield $1.39, a measly 39 percent return (again, after inflation) over a 200 year period. Gold did perform quite well compared to the dollar, giving this investment some merit during inflationary times, but it was trumped in a large way by the financial Ace of Spades: Stocks.
According to Siegel’s research stocks returned between 6.5 and 7 percent over a long run period since 1802. Also, when considering a longer time frame, stocks earned this return with less risk than any fixed income asset. Clearly, gold is not as an attractive long term vehicle for market beating returns. In the following sections I will speculate why this is so.
Gold Has no Real Economic Use
The only two real uses I can find for gold are a “store of value” and the making of jewelry. Store of value is just an economic term that means an object can maintain its purchasing power compared to the future. Gold serves this function very well over long run ($1 in 1802 turned into gold would become $1.39 in 2003). Also, gold is used to make jewelry, but this attribute is also based on its store of value properties. Gold is not useful virtually anything else in our society and the only reason that gold maintains its store of value properties is because people think it’s valuable.
Oil on the other hand is very different situation. Firms and individuals alike need oil in their everyday life for both transportation and production. The demand for oil is driven by how much oil firms and people need. The demand for gold, however, is driven solely by how much people believe it’s worth (like a famous art painting). There is no economic force driving the price of gold other than psychology. There are no profits, earnings or cash flows to determine the true value of the commodity. This makes the supply and demand relationship extremely hard to predict. For those gold traders who have already made 30 percent, how do they know when to sell? There are no fundamentals for which to base their actions.
Some investors might argue with me and say that inflation and recession statistics provide a guide. However, stocks provide a very safe hedge against inflation according to Siegal’s work (if Coke is worth $100 billion in Year 1 and inflation is three percent then the value of the company’s assets, brand name and completive advantages would also increase by three percent giving the company a value of $103 billion, everything else being constant). Also, stocks provide their greatest returns coming out of recessions and times of market trepidation.
Lastly, Gold is subject to constant “share dilution.” Since gold is never actually used to produce anything, as more and more gold is discovered each ounce of gold becomes less and less rare. This process devalues the gold on the outstanding market and as the price of gold rises there is a strong drive to discover and facilitate new supplies. This process can adversely affect the price of current holders.
Gold may go higher in the near term, but stocks will prove to be a fruitful investment in the long run.